Just how do you accurately compare the financial returns from solar or other renewable investments with the alternative vehicles you have for investing your money?
Earlier this year, energy minister Greg Barker caused a bit of a stir when he pointed out that returns from well sited solar are higher than those from an annuity. The “Are solar panels better than pensions?” debate got me wondering about how you really compare Feed in Tariff returns to other investment vehicles. For a corporate accounts department these comparisons are probably straightforward but most of us everyday householders don’t have that background. If you are like me, your awareness of investment rates is based on occasional exposure to quoted rates in ads or marketing material.
|Investment||Capital tied up for||Tax free||Key risks||Return||Equivalent Rates|
|Pre-tax nominal||Post-tax nominal||Post-tax real|
|Pensions||Up to 40 years||Yes||Economic
|4%-8% (post-tax, nominal)||6.7%-13.3%||4%-8%||1.3%-5.3%|
|5 years||Yes||Essentially risk-free||0.5% (post-tax, real)||5.3%||3.2%||0.5%|
|Buy to Let||Effectively 5 years or more||No||Rental values, growth in property prices||9% (pretax, nominal)||9.0%||5.4%||2.7%|
|Repayment of mortgage||Several years (until owner moves house)||Yes||Interest rates||4.8% (post-tax, nominal)||8.0%||4.8%||2.1%|
|Small-scale FITs||As for property||Yes||Operational||5%-8% (real post-tax)||12.8%-17.8%||7.7%- 10.7%||5%-8%|
I don’t think anyone was seriously suggesting that the UK population should rush out and abandon pensions for panels. Greg Barker’s attempt to highlight the real returns from solar panels does make for some interesting comparisons though. If you try to compare pension investment to getting solar panels for your home you end up with a lot of complexity. It is not simply a matter of comparing interest rates. Pension companies will point out that contributions to pensions are tax free. On the other hand, income from your annuity is taxable. Income from your Feed in Tariff is tax free. If an 8% return from solar panels is achievable, it is not just a question of whether this is higher than annuity rates. The impact of tax and the index linking of the FIT payments is incredibly significant.
The point of this post is not to set up some phony war between pensions and solar panels. In the case of home solar, we are talking about an investment of perhaps £4,500 – £8,500, that’s only a fraction of the investment you would need in your pension. The complexity of the comparison is the interesting thing. Some investment options are tax free, others are taxed. Some have variable returns, some have guarantees. Some tie up your money for short periods and some for long ones. Some provide an income and others a lump sum. In the case of pensions, there is the crucial fact that your employer contributes. Your employer is not likely to pay for your solar panels. On the other hand, your pension will often provide a tax free lump sum and an annuity on retirement. Solar panels might well be an option for what do do with the lump sum?
The figures in the table above are taken from a report called “Updates to the Feed-in-Tariffs Model, Documentation of Changes for Solar PV Consultation”. The report is by Cambridge Economic Policy Associates Ltd and Parsons Brinckerhoff and was submitted to DECC in October 2011.
This information is a few years old, so it is unlikely to give you an accurate comparison of the actual returns available from other investments today. What I found it really useful for, was comparing the effects of pre-tax and post-tax rates and the impact of the index-linking of the Feed in Tariff payments. The figures above assume inflation at 2.7% and tax at 40%.
Real rates take into account the decreasing value of money over time, due to inflation. Because FIT payments are index linked, they rise in line with the Retail Price Index. If, like me, your awareness of your investment options starts from quoted rates then the method above gives you a starting point for comparing your options. If an investment option, like the Feed in Tariff or the Renewable Heat Incentive, rises in line with the Retail Price Index then you are better off by the rate of the RPI vs a nominal rate. For reference, the RPI 12-month rate for June 2014 stood at 2.6%. The annual RPI adjustment to the FIT rates applied in April 2014 was 2.7%.
There are still many other things to consider. Whether you feel your investment options are high or low risk, for example. In the case of renewable energy for your home you might consider how likely you are to move house in the next few years. If you do, whether you are likely to be able to realise the value of your renewable system in the form of an increased sale price for your house? What is very interesting in reading the updates to the Feed in Tariff model is just how good an investment those advising DECC clearly believe small scale FIT is, when compared to the other options available to householders.